UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Form 10-Q

x	Quarterly report pursuant to Section 13 or 15 (d) of the Securities Exchange Act of 1934

For the quarterly period ended September 30, 2004

or

o	Transition report pursuant to Section 13 or 15 (d) of the Securities Exchange Act of 1934

For the transition period from       to

Commission File Number 0-29993

INTRABIOTICS PHARMACEUTICALS, INC.

2483 East Bayshore Road, Suite 100
Palo Alto, CA 94303

(Address of principal executive offices)

(650) 526-6800

(Registrant’s telephone number including area code)

Indicate by check mark whether the Registrant: (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o

Indicate by checkmark whether registrant is an accelerated filer (as defined in Rule 12b-2 of Securities Exchange Act of 1934). Yes o No x

There were 8,866,127 shares of the Registrant’s common stock, par value $0.001, outstanding as of September 30, 2004.

TABLE OF CONTENTS

INTRABIOTICS PHARMACEUTICALS, INC.

FORM 10-Q

QUARTER ENDED September 30, 2004

TABLE OF CONTENTS

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PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

INTRABIOTICS PHARMACEUTICALS, INC.

See accompanying notes.

3

INTRABIOTICS PHARMACEUTICALS, INC.

(UNAUDITED)

See accompanying notes.

4

INTRABIOTICS PHARMACEUTICALS, INC.

(UNAUDITED)

See accompanying notes.

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INTRABIOTICS PHARMACEUTICALS, INC.

Note 1. Basis of Presentation and Summary of Significant Accounting Policies

     The accompanying condensed financial statements are unaudited and have been prepared by IntraBiotics Pharmaceuticals, Inc. (the “Company”) in accordance with the rules and regulations of the Securities and Exchange Commission for interim financial information, and in accordance with the instructions to Form 10-Q and Article 10 of Regulation S-X.

     Certain information and footnote disclosures normally included in the Company’s annual audited financial statements (as required by accounting principles generally accepted in the United States) have been condensed or omitted. The interim condensed financial statements, in the opinion of management, reflect all adjustments (consisting entirely of normal recurring adjustments) necessary for a fair presentation of the Company’s financial position as of September 30, 2004, the results of its operations for the three and nine-month periods ended September 30, 2004 and 2003 and cash flows for the nine-month periods ended September 30, 2004 and 2003.

     The results of operations for the interim periods are not necessarily indicative of the results of operations to be expected for the entire fiscal year. These interim condensed financial statements should be read in conjunction with the audited financial statements for the year ended December 31, 2003, which are contained in the Company’s Annual Report on Form 10-K, and filed with the Securities and Exchange Commission on March 19, 2004. The condensed balance sheet as of December 31, 2003 is derived from such audited financial statements.

Use of Estimates

The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes, including amounts accrued for clinical trial costs, stock-based compensation and restructuring charges. Actual results could therefore differ materially from those estimates under different assumptions or conditions.

Note 2. Stock-Based Compensation

     In February 2003, the Board approved a cancellation and re-grant of unexercised stock options to purchase 308,835 shares of common stock held by existing employees and directors of the Company in a one-for-one exchange and options to purchase 12,500 shares of common stock that were re-granted in connection with the cancellation of unexercised stock options to purchase 54,166 shares of common stock held by a director of the Company. The newly granted options have an exercise price equal to the closing price of the Company’s common stock on the Nasdaq National Market on February 5, 2003, or $2.76 per share. These options generally vest over a four-year period and will expire in February 2008 if not previously exercised. Variable accounting is being applied to the newly granted options throughout their term.

     As permitted by Statement of Financial Accounting Standards No. 123 (“SFAS 123”), “Accounting for Stock-Based Compensation,” as amended by Statement of Financial Standards No. 148, “Accounting for Stock-Based Compensation - Transition and Disclosure,” the Company has elected to follow APB 25 and related interpretations in accounting for stock-based employee compensation. Under APB 25, if the exercise price of an employee or director stock option is set equal or in excess of the fair market value of the underlying stock on the date of grant, no compensation expense is recognized. In February 2003, certain stock options for which the exercise prices had originally been set at less than the fair market value of the underlying stock on the grant date, were cancelled and re-granted in a one-for-one exchange. The Company had recorded deferred compensation for the difference between the original exercise price and the fair market value of the underlying stock on the grant date as a component of stockholders’ equity, and the total was being amortized on a straight-line basis over the vesting period of the original awards, ranging from four to six years. The related re-granted options all vest over a four-year period, and the remaining unamortized deferred compensation as of the re-grant date is now being amortized over the new four-year vesting schedule, commencing at the date of re-grant.

     Options or stock awards issued to non-employees are recorded at their fair value as determined in accordance with SFAS 123 and the FASB’s Emerging Issues Task Force issue No. 96-18, “Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services,” and are recognized over the related service period and are periodically re-measured as the underlying options vest.

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     The following table illustrates the effect on net loss applicable to common stockholders and net loss per share applicable to common stockholders if the Company had applied the fair value recognition provisions of SFAS 123 to stock-based employee compensation (in thousands, except per share amounts):

     The fair value of the Company’s stock options granted to employees was estimated at the date of grant using the Black-Scholes option pricing model for the three- and nine-month periods ended September 30, 2004 and 2003 with the following weighted-average assumptions:

Note 3. Comprehensive Loss

     The components of comprehensive loss in each period presented are as follows:

Note 4. Net Loss Per Share

     Basic and diluted net loss per share applicable to common stockholders is presented in accordance with Financial Accounting Standards Board Statement No. 128, “Earnings Per Share,” and is calculated using the weighted-average number of shares of common stock outstanding during the period. Diluted net loss per share applicable to common stockholders includes the impact of potentially dilutive securities (stock options, warrants and convertible preferred stock). As the Company’s potentially dilutive securities were anti-dilutive for all periods presented, they are not included in the calculations of diluted net loss per share applicable to common stockholders. The total number of shares underlying the stock options, warrants and convertible preferred stock excluded from the calculations of diluted net loss per share applicable to common stockholders was 3,764,721 and 3,200,874 for the three-month periods ended September 30, 2004 and 2003, respectively, and 3,632,723 and 2,991,807 for the nine-month periods ended September 30, 2004 and 2003, respectively.

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Note 5. Commitments

     At September 30, 2004, the Company has a total of $413,000 in commitments to its contract manufacturer for drug substance, representing $250,000 due upon acceptance of an existing drug order, for which delivery is expected in the fourth quarter of 2004, and $163,000 in fees for storage of iseganan through December 2007. Regardless of whether the order is accepted and whether the related $250,000 is paid or not, we intend to both terminate the drug storage agreement and destroy all iseganan inventory by December 31, 2004, which would result in a reduction in the drug substance commitments of $150,000.

     The Company occupies office space in Palo Alto, California under the terms of a lease, which terminates at the end of June 2005. Under the terms of the lease, the Company is committed to pay rent of approximately $24,000 in 2004 and $49,000 through June 2005 and has the option to extend the lease term until December 31, 2005 at the then market rate.

Note 6. Stockholder’s Equity

     On May 10, 2004, the Company issued and sold 3,000,000 shares of common stock, $0.001 par value, in an underwritten public offering, and on June 8, 2004, the underwriters exercised their over-allotment option to purchase an additional 450,000 shares of common stock. The combined sale of 3,450,000 shares resulted in total net proceeds of approximately $41.5 million, based on a public offering price of $13.00 per share, and after deducting the underwriting discount and commissions and other offering expenses.

Note 7. Restructuring Charge

     In June 2004, the Company discontinued its clinical trial of iseganan for the prevention of ventilator-associated pneumonia (“VAP”), following a recommendation of the independent data monitoring committee. The Company has since terminated its iseganan development program, and is focusing efforts on evaluating various strategic options, which may include mergers, acquisitions, in-licensing opportunities, and liquidation of the Company. As a result, in August 2004, the Company implemented a restructuring plan, which includes the termination of nine employees and various operating lease commitments. When the restructuring plan is fully implemented, the Company will have six employees and occupy one office in Palo Alto, California.

     In accordance with Statement of Financial Accounting Standards No. 146 (“SFAS 146”), “Accounting for Costs Associated with Exit or Disposal Activities,” the Company recorded a restructuring charge of $791,000 during the three months ended September 30, 2004, of which $681,000 related to involuntary employee termination benefits and $110,000 related to the termination of certain operating leases and the write-off of certain leasehold improvements. As of September 30, 2004, approximately $619,000 of the restructuring charge remained unpaid and is included under the caption “Accrued restructuring charge” on the accompanying balance sheet. The following table displays the activity in, and balances of, the accrued restructuring charge account for the three and nine months ended September 30, 2004:

     The Company expects to record additional expense of $76,000 in the three months ending December 31, 2004 related to involuntary employee termination benefits as a part of this restructuring. All liabilities relating to the restructuring are expected to be settled by December 31, 2004.

Note 8. Legal Proceedings

     Beginning on July 2, 2004, three purported class action shareholder complaints were filed in the United States District Court for the Northern of California against IntraBiotics and several of its officers. The actions were purportedly brought on behalf of purchasers of IntraBiotics common stock between September 5, 2003 and June 22, 2004 and generally allege that the defendants made false or misleading statements concerning the clinical trial of iseganan. The plaintiffs seek unspecified monetary damages. The Company believes the suits to be without merit and intends to defend itself vigorously. Due to the uncertainties surrounding the final outcome of this matter, no amounts have been accrued at September 30, 2004.

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ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

     The following discussion and analysis of our financial condition and results of operations should be read together with our financial statements and related notes included in our quarterly report on this Form 10-Q and in our annual report on Form 10-K for the year ended December 31, 2003. This discussion and analysis contains forward-looking statements that involve risks, uncertainties and assumptions. The actual results may differ materially from those anticipated in these forward-looking statements as a result of many factors, including but not limited to those set forth under “Factors That Could Affect Future Results”. All forward-looking statements included in this document are based on information available to us on the date of this document and we assume no obligation to update any forward-looking statements contained in this Form 10-Q.

Overview

     Since inception, we have devoted substantially all of our efforts to research and development of anti-microbial drugs, and have generated no product revenues. From the fourth quarter of 2002 until June 2004, we focused our efforts on developing iseganan for the prevention of ventilator-associated pneumonia (“VAP”). In June 2004, we discontinued our clinical trial of iseganan for the prevention of VAP following a recommendation of the independent data monitoring committee. We have since terminated our iseganan development program, and are now evaluating our strategic options, including mergers, acquisitions, in-licensing opportunities, and liquidation of the Company. We have retained the investment banking firm, Lazard, to advise the Company in evaluating its strategic options. Our future operations and financial condition will depend on the direction that we elect to pursue.

     As of September 30, 2004, we had a total of $53.3 million in cash, cash equivalents, restricted cash and short-term investments, and current liabilities totaled $2.0 million. We have no long-term debt or other long-term obligations. Based upon currently projected expenses for the remainder of 2004, we expect to have available cash and investments of between approximately $46.0 million and $50.0 million at December 31, 2004, after providing for current liabilities. There can be no assurance that such a range will be achieved, as actual expenditures may differ significantly from projected expenditures. Our accumulated deficit as of September 30, 2004 was $230.7 million.

     We intend that the following discussion of our financial condition and results of operations will provide information to assist in the understanding of our financial statements, the changes in certain key items in those financial statements from year to year, and the primary factors that accounted for those changes, as well as how certain accounting principles, policies and estimates affect our financial statements.

Critical Accounting Policies

General

     Our discussion and analysis of our financial condition and results of operations is based upon our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities and expenses, and related disclosures. On an ongoing basis, we evaluate these estimates, including those related to clinical trial accruals, stock-based compensation and restructuring charges. Estimates are based on historical experience, information received from third parties and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results could therefore differ materially from those estimates under different assumptions or conditions.

     An accounting policy is deemed to be critical if it requires an accounting estimate to be made based on assumptions about matters that are highly uncertain at the time the estimate is made, and if different estimates that reasonably could have been used, or changes in the accounting estimates that are reasonably likely to occur periodically, could materially impact the financial statements. Management believes the following critical accounting policies reflect its more significant estimates and assumptions used in the preparation of the financial statements.

Clinical Trial Accruals

     The Company’s accrued costs for clinical trial activities are based upon estimates of the services received and related expenses incurred that have yet to be invoiced by the contract research organizations (CROs), investigators, drug processors, laboratories, consultants, or other clinical trial service providers that perform the activities. Related contracts vary significantly in length, and may

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be for a fixed amount, a variable amount based on actual costs incurred, capped at a certain limit, or for a combination of these elements. Activity levels are monitored through close communication with the service provider, including detailed invoice and task completion review, analysis of expenses against budgeted amounts, and pre-approval of any changes in scope of the services to be performed. Each CRO provides an estimate of costs incurred but not invoiced at the end of each period for each individual trial. The estimates are reviewed and discussed with the CRO as necessary, and included in research and development expenses for the related period. For investigator study grants, which are paid quarterly on a per-patient basis to the institutions performing the clinical study, the Company accrues an estimated amount based on patient enrollment in each quarter. All estimates may differ significantly from the actual amount subsequently invoiced. No adjustments for material changes in estimates have been recognized in any period presented.

Stock-Based Compensation

     In February 2003, the Board of Directors approved a cancellation and re-grant of unexercised stock options to purchase 308,835 shares of common stock held by existing employees and directors of the Company in a one-for-one exchange and options to purchase 12,500 shares of common stock that were re-granted in connection with the cancellation of unexercised stock options to purchase 54,166 shares of common stock held by a director of the Company. The options generally vest over a four-year period and will expire in February 2008 if not previously exercised. Variable accounting is being applied to the re-granted options throughout their term. The related compensation expense depends on both the cumulative vesting of outstanding options and the price of the Company’s common stock at each quarter end, and therefore may have a significant impact on the Company’s future results of operations. No adjustments for material changes in estimates have been recognized in any period presented.

     As permitted by Statement of Financial Accounting Standards No. 123 (“SFAS 123”), “Accounting for Stock-Based Compensation”, as amended by Statement of Financial Standards No. 148, “Accounting for Stock-Based Compensation - Transition and Disclosure,” the Company has elected to follow APB 25 and related interpretations in accounting for stock-based employee compensation. Under APB 25, if the exercise price of an employee or director stock option is set equal or in excess of the fair market value of the underlying stock on the date of grant, no compensation expense is recognized. In February 2003, certain employee and director stock options for which the exercise prices had originally been set at less than the fair market value of the underlying stock on the grant date, were cancelled and re-granted in a one-for-one exchange. The Company had recorded deferred compensation for the difference between the original exercise price and the fair market value of the underlying stock on the grant date as a component of stockholders’ equity, and the total was being amortized on a straight-line basis over the vesting period of the original awards, ranging from four to six years. The related re-granted options all vest over a four-year period, and the remaining unamortized deferred compensation as of the re-grant date is now being amortized over the new four-year vesting schedule, commencing at the date of re-grant. The amount of deferred stock compensation expense to be recorded in future periods could decrease if options, for which accrued but unvested compensation has been recognized, are forfeited prior to vesting. No adjustments for material changes in estimates have been recognized in any period presented.

     Options or stock awards issued to non-employees are recorded at their fair value as determined in accordance with SFAS 123 and the FASB’s Emerging Issues Task Force issue No. 96-18, “Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services”, and are recognized over the related service period and are periodically re-measured as the underlying options vest. The fair values are estimated using the Black-Scholes option pricing model, and are periodically re-measured as the underlying options vest. The option pricing model is dependent on a number of inputs, which may change over time. Other option pricing models may produce fair values that are substantially different from the Black-Scholes model. No adjustments for material changes in estimates have been recognized in any period presented.

Restructuring Charge

     The Company accounts for restructuring charges in accordance with Statement of Financial Accounting Standards No. 146 (“SFAS 146”), “Accounting for Costs Associated with Exit or Disposal Activities.” The charges in the income statement include estimated or actual charges for the termination of employees and various operating leases, and the write-off of leasehold improvements. Restructuring charges that remain unpaid at each period end are included under the caption “Accrued restructuring charge” on the balance sheet. We continue to monitor actual costs and expected remaining obligations in connection with our restructuring plan, and revise estimated amounts accordingly. All estimates may differ significantly from the actual amount incurred. No adjustments for material changes in estimates have been recognized in any period presented.

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Results of Operations

Three- and Nine-Month Periods Ended September 30, 2004 and 2003

     Research and Development

     Research and development expenses primarily include clinical trial expenses, research and development payroll expense, drug substance expense, allocated facilities costs and non-cash stock compensation. The expense in the three months ended September 30, 2004 primarily relates to the winding-down of the clinical trial of iseganan for the prevention of VAP, which commenced in September 2003 and was discontinued in June 2004 following a recommendation of the independent data monitoring committee. Research and development expenses decreased to $2.1 million in the three months ended September 30, 2004 as compared to $3.6 million in the same period of 2003. This decrease is primarily a result of a write-off of $2.4 million of prepaid iseganan drug substance in the three months ended September 30, 2003, partially offset by higher expenses related to CROs and investigators in the three months ended September 30, 2004.

     Research and development expenses increased to $11.0 million in the nine-months ended September 30, 2004 as compared to $5.3 million in the same period of 2003. This increase is primarily due to expenses relating to the discontinued clinical trial of iseganan for the prevention of VAP, with higher expenses related to investigators, CROs, salaries and lab fees being partially offset by the write-off of $2.4 million of prepaid iseganan drug substance in the nine months ended September 30, 2003.

     We have terminated our iseganan development program and we do not plan to re-commence or start new clinical trial activities for iseganan. We expect our research and development expenses in the three months ending December 31, 2004 to be substantially lower than in prior periods, primarily as a result of the discontinuance of the VAP trial and related reduction in personnel and facilities discussed below in “Restructuring Charge”.

     General and Administrative

     General and administrative costs primarily include administrative payroll expense, outside contractors, legal and accounting fees, insurance, non-cash stock compensation, facilities and other general administrative expenses. General and administrative expenses were $1.1 million and $3.8 million for the three and nine months ended September 30, 2004, which approximate the amounts in the comparable periods of 2003. A reduction in stock compensation expense of $0.3 million in the three months ended September 30, 2004 as compared to the comparable period of 2003, was offset by higher consulting and professional fees. During the nine months ended September 30, 2004, stock compensation was lower by a total of $0.7 million than the corresponding period of 2003, which was offset by higher consulting and recruitment fees and other general expenses. The lower stock compensation expense is primarily as a result of a net non-cash stock compensation recovery of $0.6 million for the nine months ended September 30, 2004. The recovery results from variable accounting being applied to stock options that were re-priced in February 2003 and a decrease in the Company’s common stock price from prior periods. We expect G&A expenditures to decrease in the fourth quarter of 2004 primarily due to the reduction in headcount discussed below in “Restructuring Charge”.

     Restructuring Charge

     In June 2004, the Company discontinued its clinical trial of iseganan for the prevention of VAP, following a recommendation of the independent data monitoring committee. The Company has since terminated its iseganan development program, and is focusing its efforts on evaluating various strategic options, which may include mergers, acquisitions, in-licensing opportunities, and liquidation of the Company. As a result, in August 2004, the Company implemented a restructuring plan, which includes the termination of nine employees and various operating lease commitments. When the restructuring plan is fully implemented, the Company will have six employees and occupy one office in Palo Alto, California.

     In accordance with Statement of Financial Accounting Standards No. 146 (“SFAS 146”), “Accounting for Costs Associated with Exit or Disposal Activities,” the Company recorded restructuring charges of $791,000 during the three and nine months ended September 30, 2004, of which $681,000 related to involuntary termination benefits and $110,000 related to the termination of certain operating leases and the write-off of certain leasehold improvements. As of September 30, 2004 approximately $619,000 of the restructuring charges remained unpaid.

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     The Company expects to record additional expenses of $76,000 in the three months ended December 31, 2004 related to involuntary termination benefits as a part of this restructuring. All liabilities relating to the restructuring are expected to be settled by December 31, 2004.

     Interest Income

     Interest income was $221,000 and $408,000 in the three- and nine-month periods ended September 30, 2004, as compared to $28,000 and $99,000 in the comparable periods of 2003. The increase in interest income resulted from an increase in average interest earning investment balances in the 2004 periods as compared to the 2003 periods, primarily due to the follow-on public offering that closed in the second quarter of 2004.

     Other Expense

     Other expense of $175,000 during the three and nine months ended September 30, 2004 represents a write-down of the remaining carrying value of certain redeemable preferred stock received related to the sale of two pre-clinical programs in 2002. Previously this preferred stock had been included under the caption “Other assets” on the balance sheet.

     Net Loss and Net Loss Applicable to Common Stockholders

     Net loss applicable to common stockholders was $4.0 million and $15.5 million for the three- and nine-month periods ended September 30, 2004, respectively, as compared to $4.8 million and $10.5 million in the same periods of 2003. The loss in the nine months ended September 30, 2003 includes the impact of a non-cash deemed dividend related to a beneficial conversion feature on our Series A preferred stock of $1.4 million. The losses also include the impact of non-cash Series A preferred stock dividends of $65,000 and $195,000 in the three- and nine-month periods ended September 30, 2004, and $70,000 and $117,000 in the comparable periods of 2003. Preferred stock dividends represent the 8% annual dividends payable quarterly in common stock to the holders of our Series A preferred stock.

Liquidity and Capital Resources

     At September 30, 2004, we had cash and cash equivalents of $3.8 million, representing a decrease of $10.5 million from the balance of $14.3 million as of December 31, 2003. Short-term investments were $49.3 million at September 30, 2004 as compared to $12.1 million at December 31, 2003. Restricted cash was $250,000 at both September 30, 2004 and December 31, 2003. We had no debt outstanding as of September 30, 2004. We invest excess funds in short-term money market funds and securities pursuant to our investment policy guidelines.

     Net cash used in operating activities for the nine-month periods ended September 30, 2004 and 2003 was $14.9 million and $6.2 million. The cash used consisted primarily of the net loss for each period, adjustments for non-cash stock compensation and changes in prepaid expenses, accrued restructuring and clinical liabilities, and other assets.

     Net cash used in investing activities for the nine-month period ended September 30, 2004 was $37.3 million and net cash provided by investing activities for the nine-month period ended September 30, 2003 was $2.9 million. The cash used in the 2004 period primarily related to the purchase of $50.7 million of short-term investments, being partially offset by proceeds from the sale or maturity of short-term investments of $13.5 million. The cash provided by investing activities during the nine months ended September 30, 2003 related to the sale or maturity of short-term investments.

     Net cash provided by financing activities for the nine-month periods ended September 30, 2004 and 2003 was $41.7 million and $3.2 million. The cash provided in 2004 was primarily related to a public offering that closed in the second quarter of 2004, in which we sold 3,450,000 shares of common stock at $13.00 per share. The net proceeds to us were approximately $41.5 million, after deducting the underwriter discount and commissions and other offering expenses. The cash provided in 2003 was primarily related to a private placement transaction in May 2003, in which we sold 350 shares of a newly created Series A convertible preferred stock and issued warrants to purchase 920,699 shares of common stock, resulting in net proceeds of $3.2 million.

     Based upon currently projected expenses for the remainder of 2004, the Company expects to have available cash and investments of between approximately $46.0 million and $50.0 million at December 31, 2004, after providing for current liabilities. There can be no assurance that such a range will be achieved, as actual expenditures may differ significantly from projected expenditures.

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Contractual Obligations

     The impact our contractual obligations as of September 30, 2004 are expected to have on our liquidity and cash flow in future periods are as follows:

(1)

Drug substance commitments are to the contract manufacturer of iseganan bulk drug substance. The commitment represents the potential payment of $250,000 upon acceptance of an existing drug order, for which delivery is expected in the fourth quarter of 2004, and $163,000 in fees for storage of iseganan through December 2007. Regardless of whether the order is accepted and whether the related $250,000 is paid or not, we intend to both terminate the drug storage agreement and destroy all iseganan inventory by December 31, 2004, which would result in a reduction in the drug substance commitments of $150,000.

(2)

Operating leases relate to the lease for our facilities in Palo Alto, California. The lease for our premises includes an option to extend until December 2005 at the then market rate for the building. Under the terms of the lease, the Company is committed to pay rent of approximately $24,000 in 2004 and $49,000 in 2005.

     There were no purchase obligations as of September 30, 2004 that included material penalties for cancellation.

Indemnifications

     In the ordinary course of business, we enter into contractual arrangements under which we may agree to indemnify the third party to such arrangement from any losses incurred relating to the services they perform on behalf of IntraBiotics or for losses arising from certain events as defined within the particular contract, which may include, for example, litigation or claims relating to past performance. Such indemnification obligations may not be subject to maximum loss clauses. Historically, payments made related to these indemnifications have been immaterial. In addition, we have entered into indemnity agreements with each of our directors and executive officers. Such indemnity agreements contain provisions, that are in some respects broader than the specific indemnification provisions contained in Delaware law. We also maintain an insurance policy for our directors and executive officers insuring against certain liabilities arising in their capacities as such. We expect to make payments under some of these agreements in connection with the class action litigation referred to in Part II, Item I — Legal Proceedings (“Class Action Litigation”). The amount of such payments cannot be determined at this time, but they could be material.

Future Capital Requirements

     We expect to continue to incur operating losses and will not receive any product revenues in the foreseeable future. Our efforts are focused on pursuing strategic options, including mergers, acquisitions, in-licensing opportunities, and liquidation of the company. We currently anticipate our cash, cash equivalents and short-term investments to be sufficient to fund the foregoing efforts through at least the end of 2005. This forecast is a forward-looking statement that involves risks and uncertainties, and actual results could vary.

Factors That Could Affect Future Results

     Our business faces significant risks and the risks described below may not be the only risks we face. Additional risks that we do not know of or that we currently believe are immaterial may also impair our business operations. If any of the events or circumstances described in the following risks actually occurs, our business, financial condition, or results of operations could be materially adversely affected.

We are currently a party to a securities litigation class action lawsuit, which, if determined adversely, could negatively affect our or limit our strategic alternatives, our financial results or business.

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     We are currently a party to Class Action Litigation that is described in detail below in “Part II, Item 1. Legal Proceedings”. The cost of defense and ultimate disposition of the Class Action Litigation could be material. We will continue to incur expenses in defending the Class Action Litigation and, although we believe this litigation is without merit, we may incur monetary losses in connection with the final disposition of this litigation that may be material. In addition, the litigation has been, and may continue to be, time consuming and costly and could divert the attention of our remaining management personnel.

Directors, executive officers, principal stockholders and affiliated entities beneficially own at least 46% of our capital stock and may be able to exert control over our activities, and the results of our operations and financial condition may suffer.

     As of September 30, 2004, our directors, executive officers, principal stockholders and affiliated entities beneficially own, in the aggregate, at least 46% of our outstanding common stock. These stockholders, if they determine to vote the same, may be able to control the outcome of any matter requiring approval by our stockholders, including the election of directors and the approval of mergers or other business combination transactions or terms of any liquidation.

The holders of our Series A preferred st